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Elevated credit costs remain a drag on earnings Broad-based stress across retail and SME; credit cost guidance increased

* Bajaj Finance (BAF)’s reported PAT in 2QFY25 grew 13% YoY to ~INR40.1b (in line). NII grew 23% YoY to ~INR88.4b (in line). Non-interest income stood at ~INR21.1b (+3% QoQ). Fee income was lower QoQ due to the transfer of the collections activity to RBL Bank (in its co-branded credit cards). 1HFY25 PAT grew 13% YoY to ~INR79.3b and we estimate 2HFY25 PAT to grew 15% YoY.

* BAF’s 2QFY25 NIM contracted ~5bp QoQ to ~9.7%. The company expects that the ~25bp reduction in repo rates will lead to a ~10-12bp expansion in the NIM. However, the company plans to leverage the NIM expansion to support the growth of some of its newer lines of business launched over the past two years. We estimate NIM at 9.8%/9.9% in FY25/FY26.

* The company has guided for AUM growth of ~27-28% in FY25, with newer businesses contributing 2-3% to this growth, while existing businesses are expected to grow at ~24-25% YoY in FY25. In the medium term, it has guided for AUM growth of ~25-27%.

* BAF is cautiously optimistic about the portfolio movement, observing that loan losses peaked in 2Q and are expected to decline to ~2% by 4Q. It has guided for credit costs of ~205bp in FY25 (vs. the earlier guidance of 1.75- 1.85%) and credit costs of 185bp-195bp for FY26.

* We cut our FY25/FY26 PAT estimate by ~2%/5% to factor in higher credit costs. We estimate a CAGR of ~27%/24% in AUM/PAT over FY24-FY27 and expect BAF to deliver RoA/RoE of ~4.1%/21% in FY27.

* While the valuations are attractive at 3.6x P/BV and 19x FY26E P/E, we believe that the asset quality stress is becoming more broad-based and spilling over to product segments across its retail and SME offerings. We do not anticipate any significant upside catalysts until it successfully navigates the challenges on the horizon. Maintain Neutral with a TP of INR7,320. AUM rose ~29% YoY; healthy new customer acquisitions

* BAF’s total customer franchise stood at ~ 92.1m, up ~20% YoY and ~5% QoQ. New customer acquisitions stood at ~4m (vs. ~3.6m YoY and ~4.5m QoQ). The company now estimates new customer acquisitions of ~15-16m in FY25.

New loans booked rose ~14% YoY to ~9.7m (vs. ~8.5m in 2QFY24).

* Total AUM grew 29% YoY and ~6% QoQ to INR3.74t. Deterioration in asset quality; GNPA/NNPA rises ~20bp/10bp

* BAF’s GS3/NS3 deteriorated with GNPA/NNPA rising ~20bp/10bp to ~1.1%/0.5%, respectively, and the Stage 3 PCR increased ~1pp QoQ to ~57%.

* Net credit costs in 2QFY25 stood at ~2.1% (PY: ~1.5%). During the quarter, stage 2 assets decreased ~INR3.6b, while stage 3 assets increased ~INR9b. The net increase in stage 2 & 3 assets was ~INR5.4b. This increase was across all retail and SME lines of businesses. We model net credit costs of 2.1%/2.0% in FY25/FY26E

Highlights from the management commentary

* The management believes that non Bajaj Auto 2W financing is a large opportunity and expects to significantly expand this business in the medium term. The company is also evaluating its strategy for the 3W business.

* Clients who have three or more live unsecured loans have a higher propensity to default and lower collection efficiencies. The proportion of non-B2B customers with 3+ unsecured loans is only ~9-10% (vs. 13% at its peak and ~8% pre-COVID).

Valuation and view

* Earlier, we were under the impression that credit costs would remain elevated in FY25 and normalize from FY26 onwards. However, the company has increased its credit costs guidance to 185-195bp (vs. 175-185bp earlier) for FY26. BAF’s key product segments (until now) have been the secular growth segments. However, its foray into multiple new areas, such as cars, tractors, CVs, and MFI, could (in future) make its growth and credit costs vulnerable to cyclicality, despite having a well-diversified product mix.

* Despite a healthy PAT CAGR of ~24% over FY24-FY27E and RoA/RoE of 4.1%/21% in FY27E, we see limited upside catalysts. Consequently, we maintain our Neutral rating on the stock with a TP of INR7,320 (premised on 3.5x Sep’26E BVPS).

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